AustralianSuper sees fewer mergers ahead

AustralianSuper expects to be involved in fewer mergers over the next five years than it previously planned, after developing a comprehensive list of criteria for assessing the commercial viability of future transactions.

In an exclusive interview with theinstoreport, AustralianSuper membership group executive Paul Schroder says he does not expect more than two or three mergers in the next five years.

“From AustralianSuper’s point of view, we think the prospects are that there will be two or three high-quality mergers in the next five years, but not five or six. That is a very big difference for us,” Schroder says.

“We used to think how many funds could we merge with? But now, we think there are only a few funds that meet our criteria and then we might not meet their criteria either.”

In the past five years, the $84 billion superannuation fund has completed a series of large and smaller mergers, including Westscheme in 2011, and AGEST and AustQ in 2013, as well as taking on several outsourcing arrangements from corporate super funds, such as IBM and Komatsu.

This experience has led the fund to develop a set of criteria that potential partner funds will have to meet for a merger to go ahead.

“We’ve been involved in a large number of mergers now,” Schroder says.

“Because we’ve done so many of them, we have now become commercially savvy about it and we’ve got to do that because we have to act in the best interest of our members.

“We’ve built a dashboard to assess whether a merger is worthwhile or not.

“There might be a couple of funds out there thinking that AustralianSuper has done all these mergers, they just want to sweep everyone up. Nothing could be further from the truth.

“We’ve got to the heart of this; we know that scale is good, that merging is good, but only if it is commercially sensible.”

The dashboard consists of five categories and any fund has to be at least profitable for merger discussions to take place, he says.

“There are five things we look at and, frankly, that will mean there will be fewer mergers because there will be fewer funds that are attractive to merge with,” he says.

“The first one is profitability: can we get a return on our investment within our four to six-year time frame? If you can’t tick the profitability box, then we won’t be merging.

“The second is impact: will the fund you are merging with be sufficiently large, in terms of members, assets, pensioners or cash flow, to change the dial?

“The third is momentum: is the fund you are proposing to merge with healthy or not?

“Because if their momentum or their trajectory is not going well, then taking them on could end up drawing up so much energy that it takes away from what you are doing.

“Fourth is fit, for example, fit in terms of the portfolio construction. Is the way they are invested and the assets they are holding a net benefit or a detraction to the members of AustralianSuper?

“If a fund holds certain assets that are a drag on performance, what would the size of that drag be and will that be justified by the other benefits? It is all about the cost/benefit framework.

“Then the last is strategic assets: are there any strategic assets represented by that fund that you wouldn’t otherwise be able to get?”

An example of a transaction that gave AustralianSuper a strategic asset was the merger with Queensland super fund AustQ.

AustQ only had $200 million in funds under management, but gave AustralianSuper 17,000 new members in a state where it had a relatively small footprint.

“We merged with AustQ, which was a very small fund, but it was very important to us to build relationships with credible, important Queenslanders because we made a strategic decision to be bigger and more significant in Queensland,” Schroder says.

“We created a Queensland advisory board and brought in the unions, brought in some really capable, high-calibre Queenslanders and asked them what our strategy should be in Queensland.

“AustQ would struggle to meet some of the other criteria I mentioned, but they brought in a strategic asset.”

The AustQ example illustrates the five-step dashboard does not place a minimum dollar value on the size of a potential merger partner.

“We have given these criteria various scoring and created a matrix to make decisions, but you’ve got to balance all of these things,” Schroder says.

“I’m not saying that you’ve got to have $4 billion, or $2 billion in assets or otherwise we are not talking. It must be profitable, but then you’ve got to look at momentum, fit, impact and strategic assets.”

The AGEST merger

At the Conference of Major Superannuation Funds (CMSF) 2015 on the Gold Coast last week, former AGEST chief executive Cath Bowtell spoke about the decision to merge with AustralianSuper.

Bowtell sketched the challenges AGEST faced and the mounting pressure from competing funds, including the introduction of low-cost competitors in the retail space, which she said put pressure on the not-for-profit model.

The fund also faced changes in its distribution channels if the modern awards system was overhauled, with members harder to come by and more fiercely fought over.

In addition, consumers were also increasingly seeking to have all their financial services bundled and accessible through one mobile platform.

“The four large banks spent more than $1 billion a year on software over the last five years. There is no way that super funds can spend this amount of money on software,” Bowtell said at CMSF.

And although the fund had strong growth, the stability of its inflows was uncertain.

“AGEST didn’t have the problem that it didn’t have good strong cash inflows,” Bowtell said.

“It had a history of very good cash inflows, but they were nearly all non-default.

“They were nearly all member investment choice, so we were very much at the whim of our members in that a change in member sentiment could mean those inflows could dry up very quickly.

“We also looked at whether in a competitive default fund tender we could have won that tender.

“Because if there is a competing fund out there that you think could win that tender, then you have to think whether you are doing the right thing by your members in continuing to take their money and manage their funds.”

In the end, there was a strong case for merging with a large and growing fund, and after a tender process it decided to merger with AustralianSuper.

“We spent $1.4 million; part of it on advisory services and the rest of it to get the merger sorted. That was about 10 per cent of our trustee budget,” Bowtell said.

“We did have an issue around a deferred tax asset that was a $50 million cost that we would have had to bear if we hadn’t been able to get that matter settled through government.

“If we wouldn’t have received relief for that asset, then the merger wouldn’t have gone ahead.

“We would have had to defer the merger until it had dropped to a more acceptable amount.”

But the benefits of the merger to AGEST members were immediate and substantial, she said.

“Just on investment costs we could see a $15 million benefit to members in the first year. Most of that was for our accumulation members,” she said.

“We had a pretty good pension and it was pretty low cost. The savings were harder to see for those members.

“But about 95 per cent of our accumulation members were getting lower fees, so it was a pretty easy decision.”

Yet the costs for AustralianSuper were much higher.

“AustralianSuper had costs as well. They had $11 million in costs, so that was quite a bit more than we had and the payback period was about four years,” Bowtell said.

Retirement assets

Although Schroder says the merger with the $5.1 billion AGEST taught him much about the commercial viability of mergers, it fitted well within the five-step dashboard.

“The fantastic thing about AGEST was that they were growing and the second thing was that a third of their assets were in the retirement phase and we desperately wanted to get scale in retirement so that we can innovate,” Schroder tells theinstoreport.

“That is the tipping point. We’ve got now $9 billion in the retirement phase; that is starting to be the sort of scale that you can innovate and you can dedicate effort to it.

“Up until then, you were not going to segregate portfolios and you were not going to offer different investment options because it was not commercially viable. Now it is.

“AGEST was growing, they were talented people and they had a third of their assets in retirement. So we look back about it very positively, but it taught us about what makes it a commercially viable proposition.”

He says AustralianSuper is currently assessing how it can best manage its portfolio, including whether it should segregate retirement assets or not.

It is also looking to develop new retirement products and is taking its lead from the Financial System Inquiry led by David Murray.

Recommendation 11 of the Financial System Inquiry report states superannuation trustees should be required to pre-select a comprehensive income product for retirement (CIPR).

The product would commence on the member’s instruction, or the member may choose to take their benefits in another way. Impediments to product development should be removed.

“We thought there was a lot in David Murray’s position on retirement income,” Schroder says.

“We thought that CIPR kind of idea was really powerful and we are putting our minds to how we can address those.

“Prior to AGEST it wasn’t commercially viable for us to innovate in the pension phase, but now we’ve got 27,500 members and 10 per cent of our assets in retirement.

“The AGEST merger helped us accelerate the development in the retirement phase.

“Our business is starting to change and we are thinking about things like auto-transfer to retirement and what it means for the savings strategy that you should have in retirement.

“We are very interested in the idea that people should be able to auto-transfer.

“This is a system based on mandates and defaults and so we should remove the impediments to that happening.

“That is not to say that we think incomes should be compulsory; we are not saying that.

“This should still be in the members’ hands to decide, but what we are saying is we’ve got to make it much easier for a member to connect to their balance and turn it into an income stream in conjunction with the age pension.”